Capping banks’ holdings of sovereign bonds could wipe trillions of euros off their capital, European Central Bank Vice President Vitor Constancio said, laying bare a rift within the euro zone’s system of central banks on the issue.

The head of the ECB’s supervisory board, Daniele Nouy, has said a bank’s exposure to a single sovereign should not be greater than 25 per cent of its own equity capital, as is the case for all other types of debt.

But Constancio said applying such a rule would either force European Union banks to raise vast amounts of Tier 1 capital or sell some of their sizable sovereign bond holdings.

“They would (face) additional Tier 1 capital needs of over 6 trillion euros or potential sales of those securities above 1.6 trillion euros,” he said in remarks prepared for a speech delivered in London.

“This is illustrative of the likely scale of disruption in sovereign debt markets, banking sector and the economy as a whole that the introduction of such a regime could bring.”

Under current international rules, holdings of sovereign bonds are treated as risk-free.

As an alternative, Constancio floated the idea of introducing risk weights - gauging holdings according to their likelihood of default - based on prices.

“A price-based regulation would allow more leeway in banks’ portfolio decisions and would also be less disruptive to the sovereign debt markets,” Constancio said.

Bundesbank executive board member Andreas Dombret suggested a third course, one potentially even more onerous for banks than that outlined by Nouy.

Dombret said bank holdings of a single country’s sovereign bonds should be capped as they are for private debt and should also be backed by capital in proportion to their riskiness.

“The Bundesbank is arguing for government bonds to be backed with a risk-appropriate amount of capital and for large exposure limits, just like those for claims on private debtors,” Dombret said.